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16. Monopoly

# 16. Monopoly - Monopoly Professor John Diamond ECON 370...

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Monopoly Professor John Diamond ECON 370: Microeconomic Theory Lecture 16

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2 Pure Monopoly: Introduction Pure monopoly market with a single seller firm demand = market demand firm demand is downward sloping monopolist can alter market price by adjusting its own output level
3 Pure Monopoly: Graph Output Level, y \$/output unit p(y) Higher output y occurs only w/ lower price, p(y)

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4 Causes of Monopolies created by law US Postal Service, airport taxis, state lotteries a patent a new drug sole ownership of a resource a toll highway formation of a cartel OPEC large economies of scale local utility company (natural monopoly)
5 Pure Monopoly: Profit Maximization Common behavioral assumption Monopolist maximizes economic profit Thus, chooses y to max (y) ) y ( c y ) y ( p ) y (

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6 Profit-Maximization ) y ( c y ) y ( p ) y ( At profit-maximizing output y*: 0 dy ) y ( dc y ) y ( p dy d dy ) y ( d dy ) y ( dc y ) y ( p dy d
7 Profit-Maximization: Graph \$ R(y) = p(y)y c(y) y (y)

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8 (y) Profit-Maximization: Graph \$ R(y) = p(y)y c(y) y y*
9 Profit-Maximization: Graph \$ R(y) = p(y)y c(y) y y* At profit-maximizing output, slopes of revenue and total cost curves are equal; MR(y*) = MC(y*) (y)

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10 Marginal Revenue: Introduction Marginal revenue - change in revenue as y increases dy ) y ( dp y ) y ( p y ) y ( p dy d ) y ( MR dp(y)/dy < 0, since slope of D -1 negative, so ) y ( p dy ) y ( dp y ) y ( p ) y ( MR for y > 0
11 Marginal Revenue: Example and Graph If p(y) = a by, then R(y) = p(y)y = ay - by 2 So MR(y) = a - 2by < a - by = p(y) for y > 0 p(y) = a - by a y a/b MR(y) = a - 2by a/2b

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12 Marginal Cost: Introduction Marginal cost - change in TC as output y increases dy ) y ( dc ) y ( MC e.g., if c(y) = F + y + y 2 , then y 2 ) y ( MC
13 Marginal Cost: Graph F y y c(y) = F + y + y 2 \$ MC(y) = + 2 y \$/output unit

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14 Profit-Maximization: An Example At profit-maximizing y*, MR(y*) = MC(y*), so if p(y) = a by and c(y) = F + y + y 2 , then MR(y*)=a-2by*= +2 y*=MC(y*), yielding: ) b ( 2 a * y ) b ( 2 a b a * by a *) y ( p
15 Profit-Maximization: Example \$/output unit y MC(y) = + 2 y p(y) = a - by MR(y) = a - 2by a

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16 Profit-Maximization: Example \$/output unit y MC(y) = + 2 y p(y) = a - by MR(y) = a - 2by ) b ( 2 a * y ) b ( 2 a b a *) y ( p a
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